Sharp Rise In Owners’ Equity Can Help Economy, But Watch Out For Trend Reversal

US home prices continue to gallop ahead. There has been a marked increase in owners’ equity. This should buoy consumer sentiment and help the economy. The risk is when – not if – the trend reverses and goes the other way.

Home prices are inflating much faster than consumer inflation. As a matter of fact, there is no comparison between the two. In January, the S&P Case-Shiller National Home Price Index jumped 11.2 percent year-over-year, which was the sharpest appreciation in 15 years. This was the 17th month in a row price grew every month month-over-month.

In that same month, core PCE (personal consumption expenditures) – the Fed’s favorite measure of consumer inflation – rose 1.48 percent y/y, before softening further to 1.41 percent in February. Last April, core PCE dipped below one percent to 0.93 percent. It has risen since but remains below the two percent threshold, which is what the Fed aims to achieve.

As a result, the spread between home price appreciation and consumer inflation has gone vertical. In January, this was 9.7 percent – the widest since February 2006 (Chart 1). This is approaching the highs of the housing bubble of the first decade this century. In September 2005, the spread printed 12.4 percent before retreating – home price appreciation of 14.5 percent and core PCE of 2.1 percent.

Low supply of homes is a major reason why home prices are skyrocketing. In February, there was two months’ inventory of existing homes and 4.8 months of new homes (Chart 2). Historically, this is a very low level of supply.

Besides, rates remain low. The Fed spends up to $120 billion/month in purchasing mortgage-backed securities and treasury notes and bonds. The 30-year fixed mortgage rate remained under three percent since last August before rising slightly past that level in late February, as long rates rallied hard.

The pace of home price appreciation has gotten so steep that sustainability increasingly is a question mark.

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